Demand Media takes cake with galling stock buyback

By Robert CyranThe author is a Reuters Breakingviews columnist. The opinions expressed are his own.

NEW YORK — Investors who think stock buybacks are bad have a new benchmark against which to channel their dislike. Demand Media, a content farm whose public offering in January briefly heralded a new boom in Internet stocks, has seen its shares plunge by half as its business model has been challenged by Google. But rather than dedicate the proceeds of the IPO to fixing the company, its board has decided to use a third of it to repurchase stock.

This is shameful for a few reasons. For starters, it contravenes the promises Demand made to prospective investors when it sold shares at $17 a pop seven months ago. Demand Media said the $71 million it was raising in its IPO — alongside existing stockholders who sold $69 million worth — was pegged for “investments in content, international expansion, working capital, product development, sales and marketing activities, general and administrative matters and capital expenditures.”

Now, if all were going well with the business, perhaps shareholders could forgive Demand for reneging on its pledges and opportunistically buying undervalued shares. But that’s not the case. The firm hasn’t shown any ability to generate profits. Revenue may be growing at close to a 40 percent clip, but costs are growing as well. In the first six months of this year, it had a net loss of $8 million — almost $2 million worse than the same period last year.

Moreover, an effort by Google in April to eliminate low-quality content from its searches dealt a hit to Demand’s business, whereby it pays an army of freelancers $15 or so for articles on topics suggested by an algorithm to maximize ad revenue. Continuing losses and Google’s efforts to deter gaming of its search mechanisms would argue for Demand to be allocating capital to its business — not to buybacks.

Of course, for insiders who might want to dump some of their shares now that post-IPO lockups are unwinding, a big repurchase like this would naturally appeal. For shareholders, particularly those sold a different bill of goods in January, it’s just galling.

Content Farms like DMD are nothing more than regurgitated information. Think about it – how much real quality will you receive from $15 freelancers? Want proof? Find any DMD content, then search a passage on Google, using quotes. You’ll be amazed at how many times the same “original content” appears on site after site. This stock was a great short at 25 and will be in penny stock land within a year.